Seadrill Partners (SDLP, Financial) has corrected sharply like all offshore drillers in the current crisis. While the stock is currently trading at attractive valuations, this article discusses the reasons to remain cautious on the stock.
The trigger for writing this article comes from the recent contract cancellation for Seadrill Partners from BP (BP, Financial). As a result of the contract cancellation with West Sirius, Seadrill Partners will be reducing its order backlog by $160 million.
An order backlog cancellation of $160 million does not look big for a company that has an order backlog of $5.6 billion for the year ended December 2014. However, the critical point here is that there can be further contract cancellations in the coming months if oil prices remain depressed.
According to Seadrill Partners’ 4Q14 presentation, the company has three more long-term contracts with BP, two contracts with Chevron (CVX, Financial), two contracts with Exxon Mobil (XOM, Financial) and one contract with Tullow Oil. The positive point is that all the contracts are with strong counterparties. However, the negative point is that even big companies are considering cutting their capital expenditures significantly if oil prices remain at lower levels. In other words, the risk might not be significant, but the risk of contract cancellation remains.
Therefore, my view for Seadrill Partners is the company has quality assets and the company has a strong order backlog, but investors need to remain on the sidelines in the coming months. It would be best to remain on the sidelines until oil prices witness sustained recovery, and that is not happening any time soon.
From a balance sheet perspective, Seadrill Partners has a total debt of $3.3 billion, and I believe that debt is not a concern for the company as long as the current order backlog sustains. With the value of drilling units at $5.1 billion, the company’s loan-to-value is 65% as of 4Q14. The implication is that the company’s debt holders have sufficient cushion through the value of vessels. However, debt holders would be more concerned about the continuity of cash flows that would service debt. Debt maturity is not a concern with the company having no significant debt maturity until 2017.
I would also like to mention here that I don’t expect the company to go for further acquisition during 2015 even when the company’s loan-to-value remains comfortable. Potential drop-down from Seadrill (SDRL, Financial) is likely to come only after the offshore drilling markets recover. The reason is that Seadrill will be delaying the delivery of new rigs in current market conditions and it might also be difficult to secure a long-term contract for new rigs.
Overall, the scenario remains challenging, not just for Seadrill Partners but for the offshore drilling industry. While Seadrill Partners has good assets, I would advise investors to remain on the sidelines even when the stock is trading at an attractive trailing 12-month EV/EBITDA of 5.47. The valuations are attractive considering the age of the rigs and the fact that all the rigs are modern.
In conclusion, I would like to add that investors also need to wait and watch for the outcome of the nuclear deal with Iran and world powers. A successful deal can imply prolonged lower oil prices and more challenge for the offshore drilling industry.
